Given Germany’s crucial role in the European economy, its economic challenges have become an international focal point. The common perspective would emphasise the present and near future. However, it’s likely that Germany’s economic issues are not only tied to the exhaustion of its economic model but also to the fact that the European Union’s largest economic project of the past 25 years – the euro – has fallen short of expectations.
It’s often noted that Germany’s economic model was built on three pillars: cheap energy (largely due to imports from Russia), access to affordable skilled labour in central and eastern Europe and exports to China. A cynic might add a fourth: shifting defence spending onto the American taxpayer.
Cheap energy has dwindled not only due to Russia’s aggression in Ukraine but also as a direct outcome of the EU’s Green Deal initiatives. The cost of labour in the ‘new EU’ has risen dramatically and the reservoir of available labour in these regions is nearly depleted. Where the Green Deal intended to bring technological leadership benefits to European industries, the reality is that Europe now imports most of its technological components from elsewhere.
Industrial slowdown
Signs of trouble, such as a slowdown in German industrial production, have been apparent since around 2018. This predates the energy price hikes. Similarly, the initial indications of decline in Germany’s pivotal industries are difficult to associate with a drop in export levels; the initial downturn was more related to weakened domestic demand. The sharp rise in inflation and the associated increase in euro-denominated labour costs in the ‘new EU’ came later.
Although Chinese automotive exports are growing rapidly, automobiles are manufactured elsewhere, including in North America, where the automotive sector (and industry in general) shows better long-term trends despite increased competition from China. With German industry already showing signs of weakening, this is further intensified with the onset of more aggressive Green Deal measures.
This leads us to the major European projects of the past quarter-century: the euro area and the Schengen Area. From an economic standpoint, the euro area is far more significant and Germany is often cited as a major beneficiary of the euro. At first glance, this seems logical for a country that is the world’s third-largest exporter. However, a look at economic performance data over the life of the euro area presents a different picture.
Figure 1. Germany not a clear economic winner among its peers
Per capita GDP to Germany, 1999 vs 2022
Source: The World Bank
Comparing the performance of large euro area economies, such as France, Italy, Spain, Finland and Austria, to Germany in 1999 (the euro’s inception) and 2022 (the latest year with complete data available in the World Bank database), it is evident that Germany has been outpaced. While this is most significant compared with the US, Israel has also overtaken Germany in per capita performance and both ‘new EU’ economies, Czechia and Poland, have significantly closed the gap with Germany. Sweden’s position has remained unchanged, while Germany has caught up to the UK’s economic performance over the same period. Within the euro area, of the large economies depicted, only Italy has notably fallen behind Germany.
25 years of the euro
As 2024 marks 25 years of the euro, economic data continues to demonstrate that the euro has not significantly boosted integration or trade gains among euro area members. However, this can already be seen through relatively simple data comparisons. For example, looking at the development of foreign trade in terms of which economies were significant in 2021 and how significant these economies were in 1999, there is no clear evidence of systematic integration in euro area trade. In terms of importance of its trading partners, there are much more ‘climbers’ out of the euro area and ‘fallers’ from it. The relative importance of the euro area in German foreign trade shrunk.
The euro has provided the German export-driven economy and its exporters with far less than most participants in today’s economic debates seem to think. But Germany has aged during the euro area’s existence. Its fertility rate in 2023 was 1.53, almost as low as Russia’s and it has created additional challenges, such as mismanaged migration. Even Germany’s once-exemplary infrastructure is no longer the standard.
Nevertheless, Germany should not be underestimated. It remains a wealthy and advanced economy, with a slightly high but still safe debt level and reserves in various areas. However, reviving the economy will need to involve processes similar to the Hartz reforms, which entailed significant adjustments to the standard of living for Germans. Yet many Germans today seem neither particularly happy nor willing to make further sacrifices.
Miroslav Singer is Director of Institutional Affairs and Chief Economist at Generali Group and a former Governor of the Czech National Bank.
